Foreign digs

Overseas gold miners have allure, but patience needed

(Editor's note -- This is an update of an Oct. 12 story to correct the spelling of the last name of Dale Doelling.)

LOS ANGELES (MarketWatch) -- With prices for gold futures closing in on $500 -- a level not seen since 1987 -- investors looking to capitalize on potential gains may be giving foreign mining stocks a fresh look.

And $500 gold may just be the beginning. Dale Doelling, chief market technician at Trends in Commodities, recently forecast prices for gold could hit $1,000 in the next two or three years, double current levels of around $480. See also related story

The foreign side of investing in gold has much to do with the fact that many of the world's biggest mines are outside of the U.S. South Africa is the world's biggest gold producer, with a plethora of companies operating there. Canada, Australia and South American countries are also gold producers.

Mining stocks have done well because they are able to readily capitalize on the rising price of bullion, said Michael Burke, co-editor at Investors Intelligence investment letter, which is 10% invested in gold-mining stocks.

"Obviously in mining stocks there's a lot of leverage if the price of whatever they mine goes up and costs stay the same," Burke said. "If the price of gold goes up 10%, mining stocks might go up 25% or 30%."

Golden sheen

Gold typically acts as a buffer against rising inflation, a pervading U.S. economic worry, and against the decline of paper assets such as stocks, bonds and the U.S. dollar. It also is viewed as insurance for investors in times of global uncertainties.

"If you look at the U.S. and we suddenly have large deficits again, that could potentially mean a declining dollar, and in the past there have been times when currencies have been completely destroyed, such as Germany in the 1920s," he said.

One major attraction for Burke is the fact that these are all Top 10 holdings of Fidelity Select Gold
FSAGX, +0.25%
fund, as of June 30. "They have good fundamental research and someone that follows closely these different stocks in specialized industries," he said. See also Gold Stocks Shine

Still, he admits investing in foreign gold stocks hasn't become wildly popular because most investors are still focusing on oil. "People that run mutual funds are not making heavy gold investments," he said.

Michael Cuggino, president and portfolio manager of Permanent Portfolio Funds, provides a couple of reasons to invest in gold itself, rather than mining stocks.

He noted that mining stocks also may hedge sales of future production. For example, if they hedge gold prices at $400 and the price goes to $450, that's a $50 loss for investors.

The Permanent Portfolio fund
PRPFX, -0.08%
actually holds 20% in gold bullion and gold coins. He said investors do need to make gold a part of their investment portfolio.

"Gold protects you so much out there. It's recognizable for its value regardless of culture or where you grew up. It's a worldwide alternative currency measure," he said.

The currency factor

Frank Holmes, chief investment officer for U.S. Global Investors, works on the premise that investors should have a 5% to 10% weighting in gold and rebalance at the end of every year. He said investors should be aware that, historically, gold corrects in October and November and rallies in August and September.

Among miners, U.S. Global Investors likes Goldcorp for the fact it pays a monthly dividend and has one of the world's richest gold mines in Ontario, yielding two ounces of gold for every ton of rock moved. "With the average gold mine you have to move five tons of rock to get one ounce of gold. It's very costly," Holmes said.

But he cautions that investors need to be aware of currency fluctuations when investing in foreign gold stocks, noting South African stocks have been gaining due to rand weakness versus the U.S. dollar, as the price of gold rises. If the rand starts to rise along with gold, with companies paying salaries and costs in rand terms, profits could be at risk, he said.

"When people look at South African gold stocks they've been rising and the price of gold has been rising, and the rand falling, but two years ago gold was rising and the rand was too and these companies underperformed," Holmes said.

That is a factor for other countries as well, he noted. "The risk here is not so much the price of gold, but the currency swing."

He also warns that many gold-mining stocks have had some performance problems over the past 14 months due to higher energy prices or higher production costs.

For some balance, he also likes U.S.-based Royal Gold Inc
RGLD, -2.98%
which just buys royalties on other gold mines, therefore avoiding potential profit problems with traditional miners.

"The big part is don't run out and buy gold to get rich. It's basically an insurance program. If the markets [or the] dollar goes under any pressure, you will perform well owning gold stocks," said Holmes.

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